INVENTORIES  The entity should be the owner of the goods in order to include the goods to
inventory
 Inventories are assets:
(a) Held for sale in the ordinary course of business;
(b) In the process of production for such sale; or
(c) In the form of materials or supplies to be consumed in the
production process or in the rendering of services.
 Net realizable value is the estimated selling price in the ordinary course of
business less the estimated costs of completion and the estimated costs
necessary to make the sale.
 Fair value is the amount for which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arm’s length
transaction.
Classes of Inventories
Trading Concern (Merchandising Concern) is one that buys and sells goods in the
same form purchased.
“Merchandise Inventory” is generally applied to goods held.
Manufacturing Concern is one that buys goods which are altered or converted into
another form before they are made available for sale.
Inventories in Manufacturing Concern
1. Finished Goods – completed products which are ready for sale.
2. Goods in Process – partially completed products which require
further process of work before they can be sold.
3. Raw Materials – goods that are to be used in the production process.
4. Indirect Materials (Manufacturing Supplies) – supplies that are not
physically incorporate in products being manufactured.
Goods includible in the inventory
 “Passing of title”
Legal Test
 Following items should be included in inventory applying legal test:
a) Goods owned and on hand
b) Goods in transit and sold FOB Destination
c) Goods in transit and purchased FOB Shipping Point
d) Goods out on consignment
e) Goods in the hands of salesmen and agents
f) Goods held by customers on approval or on trial
 EXCEPTION to Legal Test:
a) Goods sold on Installment Basis –ownership of buyer
b) Undelivered Customized Goods – ownership of buyer
Goods in Transit
F.O.B – Free On Board
 FOB Destination – ownership of goods is transferred only upon receipt of
goods by buyer at point of destination.
a) Goods in Transit are property of seller.
b) Seller is legally responsible for freight charges.
 FOB Shipping Point - ownership of goods is transferred upon shipment of
goods.
a) Goods in Transit are property of buyer.
b) Buyer is legally responsible for freight charges.
Freight Terms
 Freight Collect – Freight charge is not yet paid by the seller. Thus, buyer
actually paid by the seller.
 Freight Prepaid – Freight charge on goods shipped is already paid by the
seller.
NOTE: The terms FOB Destination and FOB Shipping Point determines the owner
and the party who is supposed to pay the freight charges while terms Freight
Collect and Freight Prepaid determines who actually paid the freight charges.
Consigned Goods
 Shall be excluded in the consignor’s inventory
 Freight and other handling cost on goods out on consignment are part of cost
of goods consigned.
ACCOUNTING FOR INVENTORIES METHODS OF RECORDING PURCHASES
1. Periodic System – relies upon an occasional physical count of the inventory 1. GROSS METHOD – Purchases and accounts payable are recorded at gross.
to determine the ending inventory balance and the cost of goods sold. 2. NET METHOD - Purchases and accounts payable are recorded at net.
2. Perpetual System – keeps continual track of inventory balances.
GROSS METHOD NET METHOD
PERIODIC PERPETUAL Purchase of merchandise on account, P200,000. 2/10, n/30
A. Purchase of merchandise on account, P300,000. Purchases 200,000 Purchases 196,000
Purchases 300,000 Inventory 300,000 Accounts Payable 200,000 Accounts Payable 196,000
Accounts Payable 300,000 Accounts Payable 300,000 CASE 1: Assume payment is made within discount period
B. Payment of Freight on Purchase, P20,000 Accounts Payable 200,0000 Accounts Payable 196,0000
Freight In 20,000 Inventory 20,000 Cash 196,000 Cash 196,000
Cash 20,000 Cash 20,000 Purchase Discount 4,000
C. Return of Merchandise Purchased to Supplier CASE 2: Assume payment is made beyond discount period
Accounts Payable 30,000 Accounts Payable 30,000 Accounts Payable 200,0000 Accounts Payable 196,000
Purchase Return 30,000 Inventory 30,000 Cash 200,000 Purchase Discount Lost 4,000
D. Sale of Merchandise on account, P400,000, at 40% gross profit rate Cash 200,000
Accounts Receivable 400,000 Accounts Receivable 400,000 CASE 3: Assume no payment is made within the year.
Sales 400,000 Sales 400,000 NO ENTRY Purchase Discount Lost 4,000
Cost of Goods Sold 240,000 Cash 4,000
Inventory 240,000
E. Return of Merchandise sold from customer, P25,000
Cost of Inventories
Sales Return 25,000 Sales Return 25,000
Accounts Receivable 25,000 Accounts Receivable 25,000
 Costs of purchase
Inventory 15,000
 Costs of conversion
Cost of Goods Sold 15,000
 Other costs incurred in bringing the inventories to their present location
F. Adjustment of ending inventory
and condition.
Inventory, end 65,000 NO ENTRY
Income Summary 65,000 Costs of Purchase

TRADE DISCOUNTS  The costs of purchase of inventories comprise the purchase price, import
duties and other non recoverable taxes and transport, handling and other
 Deductions from price in order to arrive at invoice price costs directly attributable to the acquisition of finished goods, materials and
 Not recorded services. Trade discounts, rebates and other similar items are deducted in
determining the costs of purchase.
CASH DISCOUNTS (PURCHASE DISCOUNTS)
 Deductions from the invoice price when payment is made within discount
Costs of Conversion
period.
 Recorded as sales discount by seller and purchase discount by buyer  Direct labor
 Variable production overhead is allocated to each unit using the actual use
 of production facilities.
 Fix production overhead allocated using the normal operating capacity of
production facilities.

Other Costs

 Other costs are included in the cost of inventories only to the extent that they
are incurred in bringing the inventories to their present location and
condition. For example, it may be appropriate to include non-production
overheads or the costs of designing products for specific customers in the
cost of inventories.

Inventory cost should exclude:

 Abnormal waste
 Storage costs
 Administrative overheads unrelated to production
 Selling costs
 Foreign exchange differences arising directly on the recent acquisition of
inventories invoiced in a foreign currency
 Interest cost when inventories are purchased with deferred settlement
terms.

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